March 14th, 2018
Representing the Troubled Taxpayer – Handling an “eggshell” audit
Author: Eric J. Rollinger
What is an “eggshell” audit?
An eggshell audit is a civil IRS examination with underlying criminal issues. Representation during an eggshell audit should be limited to: tax controversy attorneys and CPAs under a Kovel agreement with a tax controversy attorney calling the shots behind the scenes. United States v. Kovel, 296 F.2d 918 (2nd Cir. 1961). The tax return preparer should NOT handle an eggshell audit.
What are the objectives and possible outcomes of an eggshell audit?
Eggshell audits have two objectives. The main objective is to prevent a criminal investigation or keep the matter a civil examination. The lesser objective is to avoid civil fraud penalties and minimize adjustments. IRC § 6663 imposes a 75% penalty on portion of underpayment attributable to fraud.
There are three likely outcomes for eggshell audits: the Revenue Agent does not discover criminal issues; the Revenue Agent discovers some or all criminal issues but is convinced to keep matter a civil examination; or the Revenue Agent makes a referral to Criminal Investigations (CI).
Statistics on Criminal Investigations
In the IRS fiscal year end 2017, Criminal Investigations (CI) commenced 3,019 inquiries. Historically, about 70% of inquiries lead to prosecutions, more than 90% of prosecutions result in convictions or guilty pleas and more that 80% of convictions and guilty pleas result in jail time or other detention. Approximately 2,000 – 2,500 individuals are convicted each year. Notables include Lawrence Taylor, Pete Rose, Darryl Strawberry, Duke Snider and Wesley Snipes.
Suggested Strategy and Best Practices
It is important to perform due diligence and prepare thoroughly for the examination. Start by reviewing all returns and information available and then having a “heart-to-heart” meeting with your client. You may want to consider a forensic examination, perform analyses of bank deposits, net worth/lifestyle, and identify all possible criminal offenses. Finally, you will want to inquire about the Revenue Agent assigned to your audit.
It is also recommended that you consider the assertion of privileges, including:
- Attorney-Client Privilege
- Federally Authorized Tax Practitioner Privilege (only applies to tax advice in non-criminal tax matters per IRC §7525)
- Fifth Amendment Privilege
- Joint Defense Privilege
- Spousal Privilege
To establish control during the examination, choose the location (preferably your office) and limit your client’s participation if possible. You will want to make and maintain the record throughout, of course ensuring that you don’t make any damaging statements that the IRS agent will note in the record. Following the examination, you can request a copy of the record including IRS agent’s notes. From those copies, only give information requested and maintain an accurate record of all copies that have been provided. Most importantly, avoid false statements, as they can lead to obstruction charges, and remain calm and collected at all times. Maintaining a good rapport with the Revenue Agent can be the difference between a criminal referral or no referral.
Warning Signs for Criminal Referrals
A criminal referral is likely if firm indications of fraud exist. I.R.M. 25.1.2 describes indications of fraud, including omissions, inability to explain large items, substantial overstatements, two sets of books, fictitious items, etc.
Warning signs for criminal referrals include:
- The Revenue Agent goes AWOL (United States v. Tweel, 550 F.2d 297 (5th Cir. 1977))
- The Revenue Agent starts to focus on the “intent” of the client toward sensitive issues
- The Revenue Agent focuses on net worth analysis or bank records
- The Revenue Agent makes excessive copy requests
- The Revenue Agent makes contact with third parties
- The Revenue Agent obtains search and seizure warrants
- Your client receives summons or subpoenas for records
Frequently Charged Tax Crimes
- IRC § 7201 – Willful attempt to evade or defeat tax (evasion)
- IRC § 7202 – Willful failure to collect or pay over tax (employment tax)
- IRC § 7203 – Willful failure to file a return, supply information or pay tax due
- IRC § 7206 – Fraud or false statements (including aiding or assisting in preparation of false returns)
- IRC § 7212 – Willful attempt to interfere with administration of internal revenue laws (obstruction)
- 18 USC § 286 – Conspiring to defraud the government
- 18 USC § 371 – Conspiring to commit offenses to defraud the government